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Tax Planning for Rental properties

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Tax Planning for Rental properties

If you owned a rental property in 2013, any net income or loss must be reported on your 2013 income tax return. Rental income is usually reported on a calendar-year basis. Any income or loss from a rental property you own outside of Canada must also be included in your return.

What can I deduct?

All reasonable expenses incurred in operating the property can be deducted. This can include the cost of insurance, property taxes, mortgage interest, electricity, heat, repairs and even advertising for tenants. If you borrowed money to make the down payment on the rental property, interest on that loan is also deductible. In certain circumstances, you may also be able to claim depreciation. However, you should be careful if you expect your expenses will consistently exceed your income from the property. If there is no reasonable expectation of making a profit from the investment, there is the possibility that your losses may be denied (see additional comments below).

Tax tip: Keep accurate records of all expenses relating to your rental property. Retain all receipts—make a small note on each one indicating what the money was spent on and why. It will help your adviser determine quickly if it’s a valid expense and eligible for deduction or depreciation.

Joint owner or partner?

If you have acquired a partial interest in a rental property, it’s important to know whether it’s in a partnership or in a joint venture. If you don’t know which it is, consult your tax adviser.

With an interest in a partnership, you must report your share of its net profit or loss on your personal tax return. Depreciation is calculated at the partnership level, not by each individual partner.

As a joint owner, you have to report your share of the revenue and expenses related to the property. Next, you calculate depreciation based on the cost of your share of the property. Your depreciation claim is independent of the depreciation that may be claimed by the other joint owners.

How much can I claim for depreciation?

In general, depreciation on a rental property cannot be used to either create or increase your rental loss. When more than one rental property is owned, all net rental income (or loss) is combined to determine the total income or loss for the year.

What happens if I sell?

Two different types of income may arise on the sale of your rental property. If you sell your property for more than its original cost, you have to report a capital gain to the extent that the proceeds exceed that cost. If the property was purchased before February 1994, some or all of this gain may have been eligible for the capital gains deduction. To take advantage of this, however, you should have made a special election when you filed your 1994 return (see topic 135).

You may also have to pay tax on income that represents previously claimed depreciation. If proceeds from the sale exceed the undepreciated capital cost (UCC) of the property, the excess, up to the original cost, is taxed as recaptured depreciation in the year of sale.

In some cases, where the property was destroyed or expropriated and another property was purchased, the gain and/or recapture may be deferred.

If you did not receive the full proceeds of the sale in the year of the sale, you may be able to claim a capital gains reserve (see topic 140). However, you cannot claim any reserve against the recaptured depreciation.

Terminal loss rules

You may have a terminal loss if the proceeds from the sale are less than the UCC of the property. You should consult with your tax adviser to assess whether this loss is deductible from your other sources of income. Based on your particular fact situation, the CRA could attempt to disallow the terminal loss on the basis that you had “no reasonable expectation of profit” from the rental of the property. This could be of particular concern where you have always reported net rental losses from the property.

There are also special rules that can reduce a terminal loss for tax purposes. If the building was sold together with the underlying land, the transaction is treated as if you sold two separate items. If the portion of the sale price attributed to the building is less than its undepreciated cost, you may be required to increase the portion allocated to the building and reduce the portion allocated to the land. This will result in a reduced terminal loss on the building.

These rules only apply to depreciable buildings and do not apply to a real estate developer who is holding real estate as inventory.

Story by: Grant Thornton LLP